Introduction to Options

Contract details refer to the terms of an option contract. How an option contract gains or loses value, and therefore creates a benefit to you as the holder of the option, is dependent on key option contract details. Understanding the key contract details is essential to determining how and when an option will meet your financial objectives. Choosing the right options contract for you is dependent on your objectives. For example, if you want to protect or hedge an asset, you will need to know the contract details to determine the best fit for your portfolio; when speculating, your trading strategy might be influenced by the contract details.

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One key characteristic of an option contract is the agreed upon price, known as the strike price or exercise price. The strike price is the predetermined price at which you buy (in the case of a call) or you sell (in the case of a put) an underlying futures contract when the option is exercised.

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A call option is the right to buy the underlying futures contract at a certain price.

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A put option is the right to sell the underlying futures contract at a certain price.

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Options buyers exercise their options. Options sellers are assigned when an option is exercised.

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European and American style options are not regional options. They are actually terms used to describe two different types of option exercise. European Style Options: can be exercised only at expiration. American Style Options: can be exercised at any time prior to expiration. The majority of CME Group options on futures are European style and can be exercised only at expiration. Some of the notable exceptions that have American style expiration are the quarterly options on the S&P500 futures contracts, SOFR options, and Treasury options.

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When traders talk about the value of an option contract, they tend to use a common set of terms to describe the varying levels of an option contract. The terms they use are time until expiration, time value, intrinsic value, and moneyness.

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Option pricing is based on the unknown future outcome for the underlying asset. If we knew where the market would be at expiration, we could perfectly price every option today. No one knows where the price will be, but we can draw some conclusions using pricing models. When looking at call options, a higher strike will cost less than a lower strike. If the underlying asset price has risen dramatically and you chose a higher strike price rather than a lower strike, your payoff will be less because you have foregone the first part of the upward price movement.

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Volatility is the bounciness of the underlying asset of an option. There are complicated formulas for measuring realized volatility, there are complicated formulas for forecasting volatility, and there are also complicated formulas for calculating implied volatility.

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